Rising NPLs To Weigh On Asset Quality And Earnings Of Bangladesh's State Banks

We at Fitch Solutions believe that rising non-performing loans (NPLs) will continue weighing on the asset quality and profitability among Bangladesh’s state-owned commercial banks (SCBs)

Our view for rising NPLs among SCBs is driven by ongoing government priority lending mandates, the lack of adequate risk management mechanisms, the banking sector’s track record of weak governance, persistent unconditional recapitalisation by the Bangladeshi government, and a poor loan recovery system in the country.

At Fitch Solutions, we are bearish with regard to the asset quality and profitability outlook of Bangladesh’s state-owned commercial banks (SCBs) as we expect non-performing loans (NPLs) to remain on an uptrend over the coming quarters. SCBs account for almost half of all NPLs in the banking sector, despite only holding a quarter of total sector assets.

Asset Quality Worsening Most Pronounced Among SCBs

Bangladesh - Gross NPL Ratio By Bank Type, %

Source: Bangladesh Bank, Fitch Solutions

We expect rising NPLs over the coming months to weigh on the asset quality of the SCBs. This will likely be worsened by rapid credit expansion amid a host of challenges faced by SCBs. The gross NPL ratio across SCBs increased to 31.2% in the quarter ending September 2018 (Q1FY2018/19), from 28.2% in the previous quarter and we expect this metric to worsen over the quarters ahead. Credit growth eased to 12.7% y-o-y in December 2018, from 13.2% y-o-y in November 2018, likely due to cautious borrowing by businesses ahead of the general elections at the end of December. Given that the elections are now behind us, we expect borrowing to pick up and we are revising up our 2019 average credit growth forecast to 13.0% in 2019 (from 12.3% previously), which while reflecting our expectation for a slight deceleration from the 2018 average of 13.9%, still remains rapid. Our view for a slight credit growth deceleration is informed by our forecast for real GDP growth to ease to 7.5% in FY2018/19 (July-June), from 7.9% in FY2017/18.

Credit Growth To Pick Up

Bangladesh - Credit Growth, % chg y-o-y

Source: Bangladesh Bank, Fitch Solutions

While rapid credit growth is by no means a bad thing, this combined with the following challenges faced by Bangladeshi SCBs inform our view for NPLs to remain on a firm uptrend. First, government mandates require SCBs to extend loans at subsidized interest rates (8% for farm loans versus the norm of about 9%) to potentially riskier priority sectors such as agriculture and small and medium businesses. As this will encourage an increase in loan demand from borrowers of a higher risk profile, we expect this to drive further upside for NPLs over the coming quarters, particularly amid a moderating economic growth outlook.

Second, an IMF report, published in June 2018, found that SCBs still lack a comprehensive risk management policy, and this compromises the sector’s ability to detect fraud early. Third, the IMF also found that SCBs have had a history of weak governance and this has resulted in significant losses for these banks. The report highlighted that independent, qualified, and reputable professionals are not always present on the boards of SCBs and that decisions were often not made in the banks’ best interests. Moreover, loan requests were found to have failed to undergo sufficient risk assessment before approval was given. There were also often no repercussions for those who responsible for the bad decisions. The second and third points further solidify our belief that the irregularities uncovered during Bangladesh Bank's (BB) investigation into The Farmer's Bank Limited and NRB Commercial Bank in March 2018 (see ‘Teetering On The Brink Of A Banking Crisis', March 14 2018) are likely to be only the tip of the iceberg and that such irregularities could still be commonplace across the banking sector. Given that little to no effort have been explicitly made towards improving these inadequacies since the report was released, we continue to believe that a large amount of new loans issued are likely still of questionable quality, and this would likely see NPLs accumulate further over the coming months.

Fourth, SCBs have also received repeated recapitalisation from the government without sufficient rectification of the underlying inadequacies with regard to their governance and lending practices. While repeated recapitalisation will allow banks to sustain a high credit growth rate, this will likely only result in a further accumulation of NPLs over time in the absence of reforms to improve the operating performance of these banks. Finally, there exists an inefficient system of NPL recovery which allows some borrowers not to repay or to delay repayment even if they are able to service their debt on time. The IMF found that resolution courts are overburdened and that the process to seize collateral is a long and time-consuming process. Moreover, borrowers are also able to file petitions to money loan courts to delay the NPL recovery process.

Weak SCB Earnings Dragging On The Broad Sector

Bangladesh - Banking Sector Return On Equity, %

Source: Bangladesh Bank, Fitch Solutions

Rising NPLs also imply the need for higher loan loss provisioning, which will weigh on the sector’s profitability. Banking sector earnings saw their worst performance in at least three years in 2018, with the sector-wide return on equity falling to 5.4%, from 9.4% and 9.6% in 2016 and 2017, respectively. The decline in profitability was largely attributed to a -12.3% return on equity from SCBs in 2018, which worsened from 3.0% in 2017. This was partially due to a 9.3% q-o-q increase in loan loss provisioning between Q4FY2017/18 and Q1FY2018/19, in response to a 12.2% q-o-q increase in classified loans across SCBs. Given our view for NPLs to remain on a firm uptrend over the coming quarters, we believe that the corresponding rise in loss provisioning will take a toll on the profitability of SCBs.